Applications in Corporate Finance - Essay Example

? Applications in Corporate Finance Table of Content Introduction 4 Background of the company 4 Situation analysis (SWOT) 5 Basically, SWOT stands for strengths (S), weaknesses (W) while on the other hand the external environmental factors are regarded as either opportunities or threats. The aim of performing a SWOT analysis is to critically analyze all the internal and external factors’ that may affect the operations of the organization (Strydom, 2004). The table below summarises the SWOT analysis for Buildalot. 5 Strength 5 Weakness 5 Opportunity 5 Threats 5 Current Situation: 6 As noted above in the situational analysis of Buildalot, the major notable problem facing the company is the lack of a proper knowledge management system despite having competent workers. The company lacks cohesion in terms of pulling the efforts of different subsidiaries together and this is the main reason why it is performing poorly. Therefore, there are certain issues that should be taken into account by Buildalot in order to improve its operations as going to be shown in the recommendations section of the report. 6 Market economy 6 Market competition 6 Equity capital structure of the company 7 PEST analysis 7 Major construction projects 8 Office building construction 9 House building construction 10 Business operational issues 11 Mayo project issues 12 Corporate social responsibilities 13 Financial statement analysis 13 Trend analysis 13 Ratio analysis 14 Recommendations 16 Referencing 18 Bibliography 20 Introduction This report deals with business analysis of Buidalot from a corporate finance perspective. This is an Ireland based Construction Company and it has been experiencing cash flow difficulties due primarily to the slow selling of houses and offices in the Mayo development project. This study will assess the major issues affecting different sectors of business in this construction company. A detailed SWOT and PEST analyses of the situation of the company will be conducted to evaluate the causes of the problems it is currently facing. This study will also evaluate the financial situation of different projects being undertaken by the company through business strategy techniques and financial strategy techniques like re-forecasting, cost of capital, net present value and business valuation. Then appropriate recommendations will be provided at the end of the report in order to effectively deal with the issues raised. Background of the company Buildalot is a 50 year old construction company and it is based in Ireland. The company was incorporated 30 years back as a group of companies. This consists of different wholly owned subsidiaries that operate in different segments of the construction industry. The three major segments that are the main focus of the company’s business include the following: major construction projects, house building construction and office building construction. The subsidiary that operates in major construction projects is based in different countries but it mainly focuses on Ireland. Office building subsidiaries undertake projects related to office constructions. It operates in Europe and Middle East along with successful penetration in the home country of Ireland. The company House building subsidiaries also operate internationally. The company initially used to engage in residential house building in Ireland and it started construction of these major segments after incorporation about 30 years ago. Situation analysis (SWOT) Basically, SWOT stands for strengths (S), weaknesses (W) while on the other hand the external environmental factors are regarded as either opportunities or threats. The aim of performing a SWOT analysis is to critically analyze all the internal and external factors’ that may affect the operations of the organization (Strydom, 2004). The table below summarises the SWOT analysis for Buildalot. Strength Weakness 1. The current ratio of the company’s working capital is high 2. The fixed asset turnover of Buildalot is also high 3. Employees are able to deal with technology 1. The company overstretches its management resources 2. The company over depends on shareholding 3. The company has a negative cashflow 4. The company seeks to grow too fast through acquisition of KLT while performing poorly in terms of selling houses Opportunity Threats 1. The company has opportunities to expand since it is involved in huge government projects 2. Good connection with clients since it has many subsidiaries and present in different areas. 1. Company’s reputation may go down due to poor project development 2. The fall of price shares is a real threat to Buildalot. For instance, the dropped from a high of ?13,86 to ?7.60 per share 3. The construction industry in Ireland is characterized by stiff competition. 4. The other threat is fluctuation of the exchange rate which is not stable Current Situation: As noted above in the situational analysis of Buildalot, the major notable problem facing the company is the lack of a proper knowledge management system despite having competent workers. The company lacks cohesion in terms of pulling the efforts of different subsidiaries together and this is the main reason why it is performing poorly. Therefore, there are certain issues that should be taken into account by Buildalot in order to improve its operations as going to be shown in the recommendations section of the report. Market economy The company mainly operates in the domestic market of Ireland. Therefore, this market has substantial influence on this business. The company has adopted different democratic principles that are meant to cater for all age groups and this has contributed to the gradual growth of expenditure of people of this country over the years. Inflation rate in this economy has remained constant at 4% per annual over last few years and GDP of this country has been expected to grow by 4% annually for next few years. Countries in European Union are the main trading partners of this country. Market competition The extent of competition among the firms in construction industry in this market is high. Eight large companies have been leading the construction market in Ireland. There are three other companies apart from Buildalot which are highly involved in the construction industry both domestic as well international markets. According to company’s annual financial data of 2010, it constructed 12% of total new units during this financial year. However, in case of international operations, its business is very small compared to other international companies. The company has generated substantial market share in Ireland especially in office construction segment. Construction projects subsidiaries were also awarded many contracts in foreign markets. Therefore, the company has successfully developed competency and brand value in domestic as well foreign markets. Equity capital structure of the company Buildalot is public limited company which has 441.6 million shares out of a total 800 million shares. The issuing price of a share is ?0.50. The company’s shares price rose up all time high to ?13.82 on 30th June, 2011. This is a good indicator of the company’s growth which was mainly influenced by its positive results in the 2010 financial year. Institutional shareholders have maximum stakes than individual shareholders on issued shares by the company. PEST analysis Kotler (1999) posits to the effect that PEST analysis is an effective management tools that is used to determine as well as to try to understand the market forces that may affect the growth of business. Basically, PEST stands for political, economic, social as well as technological factors that can affect the operations of business. There are many external factors that affect the operations of different organizations and these should be taken into consideration by the mangers since they have a bearing on the operations of a given company. The table below outlines the external forces that are likely to impact on the operations of Buildalot Co in its operations. PEST analysis for Buildalot Political The Irish government has a major responsibility of setting the expected standard operations of all companies involved in this particular industry. Hence, the operations of Buildalot are shaped by the political system obtaining in different countries it operates in including Ireland Economy -The aspect of fluctuations in the exchange rate impacts on the operations of Buildalot. For instance, from mid-September 2011, exchange rate turbulence in Ireland as well as in several other non-Euro European and some Middle East countries was witnessed for a few weeks. This compelled the Irish government to announce a 2%rise in its interest rates on 1 October 2011 in an attempt to protect its exchange rate. However, inflation rate is stable -The other economic factor that affects the operations of Buildalot is related to declining price of shares Social Buildalot is an equal opportunity employer. It caters for people from different social backgrounds who have different cultures. -Other social factors such as age, gender as well as social class also affect the purchasing trends of properties such as houses by different people in Ireland. Technological There are various technological developments that shape the operations of Buildalot. The company uses different types of earthmoving equipment in carrying out its work. Major construction projects This is one of the three major segments of subsidiaries of the company. This division of the company has five major ongoing projects. These include a national sports stadium in Middle East with forecasted profitability of ?78 million over four years; a motorway in Middle East with forecasted profitability of ?380 million over 2.4 years; a road and motorway construction in home country with forecasted profitability of ?220 million; another construction work in Ireland with forecasted profitability of ?270 million and a motorway and bridge construction in Northern Ireland. Though the company is currently involved in these projects with huge amount of projected profitability, it does not have any activity in foreign market in this segment of major project construction. Therefore, it is one of the major issues of this division of its business which is totally dependent on the domestic market demand and any macro environmental factors would have major impact on this business. Therefore, risk is high. Another important issue in this business is projected loss of ? 35 million in motorway project of Northern Ireland due to heavy rainfall during the construction process. The company has been engaging the Government authorities for compensation regarding this unforeseen rainfall damage. This may impact on the relationship between the company and the government which might affect its chances of obtaining future projects from government. This has become one major issue related to management of the company. The top management and the board of directors have conflicting views among themselves regarding this loss and concession from governments. This is a big issue in this division as well as the company as a whole. Office building construction Office building construction is one of the leading subsidiaries of the company which is involved in office building in Ireland and foreign market. Revenue has been raised during the last seven years from ?732 in 2003 to ?768 in 2010. But this is very much negligible growth rate of the company as the duration for this small amount of increase of revenue is 7 financial years. This is because of decline in profitability in some of the current projects being undertaken by the company the company. Though this business has started expanding and revenue is expected to increase substantially in 2011, it can be noted that the size of this subsidiary is very small compared to other two subsidiaries of the company. This subsidiary has contributed only 12% of the total revenue generated by Buildalot group. The other major issue of this company subsidiary is that it does not have strong capital injection for more new projects at a given period. House building construction This subsidiary is the largest among all three subsidiaries of Buildalot group and it has been divided into three geographical divisions for domestic operation such as USA and UK operations. The financial base of this subsidiary is also stronger than the other two. It also acquired one US based small construction company in order to expand its US operations. This has helped the company to gain innovative designs from the acquired company. This subsidiary uses foreign exposure in the area of cost effective business operation especially in the foreign markets. The company has started focusing on multiple activities at the same time. It is the oldest business of Buildalot and has been enjoying profitability over the years. Profitability of the overall group of companies can be evaluated carrying out an analysis of return on capital used. But, the company has found this measure misleading at the time comparing the value among the three subsidiaries of this company. The main reason behind this mismatch or misleading of profitability calculation is major increase in purchasing cost of one of the three divisions of this subsidiary. This is one key financial issue of the company. One influence behind this issue is size of this subsidiary company. Generally, small construction project provides much lower return than large development projects. Therefore, larger housing complexes or apartments give higher return on capital injected by the company than small or medium projects. Another influence is the type of apartment such as design, location and many other factors which have substantial impact on the return on capital employed by the company. Business operational issues Generally, construction companies use a mixture of local subcontractors and own employees for various business operations. The company uses subcontractors for construction work and employees for internal business activities like marketing and sales. Subcontractors also recommend the company for any necessity of extra employees for the company. This helps the company to a larger extent since it enhances flexibility and reduction of wage cost. However, the operation management of the company has been facing some issues regarding subcontractor management (Sage & Rouse, 2011, p.599). Though the company uses the same subcontractors repeatedly for its construction work, they are unable to meet the project deadlines due to limited numbers of skilled workers. This leads to major delay in initial carrying out different projects and faults are also identified in some cases. Subcontractors generally recruit unskilled workers in their team due to the fact that they give them low wages and it is the main cause of this issue. They use incentive based labour management for faster completion of work which leads to rushed work and sometimes quality of work is compromised. Buildalot uses its own employees in office building construction and major project management divisions. To overcome this major issue related to subcontractor management, the company needs to rely on its own workers. For this purpose, it needs to hire its own specialists who will track the day to day activities of subcontractors and to carryout thorough quality check of their work (Neeraj & Neeraj, 2008, p.139). Mayo project issues The Irish government has initiated the development of a countryside area of Ireland named Mayo. There has been much news from media regarding tendered construction company for this large project. Finally, Buildalot has been awarded this project by Irish government at a price of ?830 million which is ?70 million lower than estimated price for this project. The company has invited domestic as well as international companies to take part in this high profile project of Irish government. Though the company has been able to sell 51% of the total plot to other construction companies, it could not find any major construction company which is interested in buying the rest part of the land for construction of office buildings. This has increased the inventory level of the company which is major issue of the company. The company’s expected total cost for this project for years would be a total of ?5000 million and it has managed to get a loan of ?900 million with 9% interest rate annually. Therefore, the company needs to depend on the internal cash inflow from this project. But a substantial amount of its total investment remains as inventory in the unsold plots of this area (Nevitt & Fabozzi, 2000). Loan amount ? 900,000,000.00 Tenure(months) ? 60.00 Interest per month ? 0.01 Monthly repayment ? 18,682,519.70 Quarterly repayment ? 74,730,078.81 From the above table, it can be said that the company needs to generate a minimum return of ?74,730,078.81 per quarter for five year period from the initiation of bank loan. This is possible only the company is able to sell its completed house buildings and office buildings on a regular basis. But, the company is also expecting to cover the working capital cost from the cash flow. Therefore, the cash inflow from this project needs to be more which might be difficult for the company since the inventory level is very high (Ehrhardt & Bringham, 2010, p.256). Corporate social responsibilities Corporate social responsibility is a major factor that has to be taken into consideration when such huge projects are being carried out. For instance, the company has to remove plants in the Mayo area to start the construction work. Bad publicity behind this project has been affecting the demand of their house buildings and office buildings. There has been lobbying by other groups which have been raising these issues and they are influencing the local people to stop the project. This is a major issue for the company and it needs to develop alternative plantation of trees in this area to counter this kind of corporate social responsibility issue. This is likely to lead to increased projected costs for this project which can affect the company. Financial statement analysis Trend analysis Trend analysis examines historical pattern of change of quantitative data like financial statements (Ehrhardt & Bringham, 2010). It provides information about the historical pattern of change in financial parameters to the investors. It also predicts future pattern of key financial indicator of a firm so that investors can predict future performance of a firm. Financial trend analysis of Buildalot includes trend of key financial indicators of the company. Revenue has increased only by 6.97% in 7 years which is very bad growth for this kind of large construction company. The operating cost has increased 5.00% only, net profit has increased 16.03% which is better compared to revenue growth rate. But it is also not good growth rate given that the duration is very long. Liability has increased nearly three times more than the fixed assets which is also a bad indication of financial structure. Ratio analysis Current Ratio: Current ratio represents the working capital position of the company as it is one of the important indicators of liquidity of a company (JMU, 2010). It measures the performance of the company regarding its ability in terms of quick payment of short term obligations of the company. Standard current ratio for positive investment decision is 2:1. Current ratio of the company is very high than standard value which is a major strength of the company. Quick ratio: Quick ratio or acid test ratio indicates that the company has enough short term assets to pay its current liabilities or not. If this ratio is less than 1 then the company cannot pay its current liabilities without using its inventory. The company is very much dependent on its inventory to pay its current liabilities as its current ratio is less than 1 which is bad liquidity status of the company (NDU, 2012, p.1). Fixed asset Turnover: Fixed asset turnover ratio indicates the company’s ability to generate revenue from the investment on fixed assets (JMU, 2010). Therefore, the higher the ratio of fixed asset turnover, the better asset performance for the company. This ratio is very high and it is also a major strength in terms of efficient asset management. Total Asset Turnover: It shows that how the company efficiently uses current and fixed assets to generate adequate revenue and it also shows the asset performance of the company (JMU, 2010). Thus, the higher the ratio, the better for the company. It also indicates the effectiveness of pricing strategy of the company. If asset turnover is less than on, then the company has been generating higher profit margin. This ratio is very low compared to fixed asset turnover and it is a weakness for the company. Total Debt to Equity: Debt to equity ratio determines capital structure of the company. It shows that contribution of total liability and total equity in the total capital of a company. This ratio shows that the company has equal influence by the creditors and shareholders of the company as current debt to equity ratio is nearly 1 (JMU, 2010, p.1). All three profitability ratios show good profitability potential of the company since all the ratios are much higher than standard value. Buildalot cash flow forecast The latest quarterly rolling cash flow forecast, of Buildalot based on recent sales projections by Thomas Leeand Geoff Hurst, shows negative cash flows for the office building and house building subsidiaries over the next few quarters, based on the assumption of continuing construction work as originally planned, and being able to secure sales later in the construction process. The table below summarises the cash flow forecast for Buildalot Cash flow projections for Buildalot Post tax net cash movements Q4 (2011) Q1(2012) Q2(2012) Q3(2012) Inflow/ (outflow) ?Million ?million ?million ?million Major construction projects +190 +220 +180 +50 Office building (550) (240) +170 +110 House building(including KLT) (750) (970) (50) +230 Loan interest (post tax) (40) (40) (40) (40) Total post tax cash flows (1,150) (1,030) +260 +350 Buildalot mainly specialises in major construction projects, office building and house building. However, a critical analysis of the cash flow of each segment shows that it is declining rather than increasing. For instance, the cash flow for major construction projects declined in 2012 to ?50 million from the ?220 million figure of 2011. On the other hand, it can be noted that the cash flow for office building also declined from ?550million in 2011 to ?240 million in 2012. However, an analysis of the cash flow for the house building segment shows that it increased from ?750 million in 2011 to ?970 million in 2012. This shows that this is the only segment which is bringing in more revenue compared to other segments. Recommendations Fom the financial and non financial analysis of Buildalot, some major issues have been identified. Therefore, the following recommendations should be taken into account by the company in order to improve its operations. First, the company needs to be less dependent on subcontractors and needs to recruit its own employees. This will help to meet the project deadlines and also to ensure good quality work. Secondly, inventory is the most crucial and very critical problem facing the company. It should highly focus on faster liquidation of huge amount of inventory which can be reinvested in new projects. In this particular case, it should sell the total land office building in Mayo area. Thirdly, proper project planning should be centralised and it should be carried out by selected representatives by the company. Currently, each subsidiary is responsible for planning its projects and this impacts the operations of the company since this type of arrangement often lacks support from other subsidiaries. This also entails that the organisational structure of the company should be realigned so that the company does not overstretch its management resources. Fourthly, the company should focus on its profitability objective than to focus on fast tracked expansion through acquisition of other companies. This enables it to realise its set objectives. Referencing Bragg, M. S. 2012. Business Ratios and Formulas: A Comprehensive Guide. John Wiley & Sons, 2012. Ehrhardt, M.C. & Bringham, E.F. 2010. Corporate Finance: A Focused Approach. Cengage Learning. JMU. 2010. Financial ratio analysis. [Pdf]. Available at: http://educ.jmu.edu/~drakepp/principles/module2/fin_rat.pdf. [Accessed on November 9, 2012]. Kotler, P. 1999, Kotler on Marketing: How to create, win and dominate Markets, Free Press, London. Lermack, B. H. 2003. Steps to a Basic Company Financial Analysis. [Online]. Available at: http://faculty.philau.edu/lermackh/financial_analysis.htm. [Accessed on November 9, 2012]. NDU. 2012. Financial Ratio Analysis. [Online]. Available at: http://www.nd.edu/~mgrecon/simulations/micromaticweb/financialratios.html. [Accessed on November 9, 2012]. Neeraj, J.K. & Neeraj, N.K. 2008. Construction Project Management. Pearson Education India. Nevitt, P.K. & Fabozzi, F.J. 2000. Project Financing. 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